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Economic environment: economic system and economic policies

The economic environment refers to all the economic factors that affect commercial and consumer behavior. The economic environment consists of all the external factors in the immediate marketplace and the broader economy. These factors can influence a business, i.e., how it operates and how successful it might become.

The economic environment consists of different things for different people. For example, for a farmer, the weather and price of fertilizers are important factors.

For a TV channel on the other hand, the growth in Internet advertising matters a great deal, but not the weather. Internet advertising matters to a TV station because the Internet competes for advertising business. For a farmer, however, advertising media is not important.

The Business Development Bank of Canada has the following definition of the term:

“The term economic environment refers to all the external economic factors that influence buying habits of consumers and businesses and therefore affect the performance of a company.”

Economic System

An economic system is an organized way in which a country allocates resources and distributes goods and services across the whole nation or a given geographic area. It is includes the combination of several institutions, entities, agencies, decision-making processes and patterns of consumption that make up the economic structure of a specific community. Hence it is a type of social system.

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An economic system defines how all the entities in an economy interact. Defining them today is much more complicated than it used to be. Ancient systems were relatively simple – trade was carried out using barter and there were very few treaties and rules of engagement.

Economic Policy

An economic policy is a course of action that is intended to influence or control the behavior of the economy. Economic policies are typically implemented and administered by the government. Examples of economic policies include decisions made about government spending and taxation, about the redistribution of income from rich to poor, and about the supply of money. The effectiveness of economic policies can be assessed in one of two ways, known as positive and normative economics.

Positive and normative economics

Positive economics attempts to describe how the economy and economic policies work without resorting to value judgments about which results are best. The distinguishing feature of positive economic hypotheses is that they can be tested and either confirmed or rejected. For example, the hypothesis that “an increase in the supply of money leads to an increase in prices” belongs to the realm of positive economics because it can be tested by examining the data on the supply of money and the level of prices.

Normative economics involves the use of value judgments to assess the performance of the economy and economic policies. Consequently, normative economic hypotheses cannot be tested. For example, the hypothesis that “the inflation rate is too high” belongs to the realm of normative economics because it is based on a value judgment and therefore cannot be tested, confirmed, or refuted. Not surprisingly, most of the disagreements among economists concern normative economic hypotheses.

Goals of economic policy. The goals of economic policy consist of value judgments about what economic policy should strive to achieve and therefore fall under the heading of normative economics. While there is much disagreement about the appropriate goals of economic policy, several appear to have wide, although not universal, acceptance. These widely accepted goals include:

  • Economic growth: Economic growth means that the incomes of all consumers and firms (after accounting for inflation) are increasing over time.
  • Full employment: The goal of full employment is that every member of the labor force who wants to work is able to find work.
  • Price stability: The goal of price stability is to prevent increases in the general price level known as inflation, as well as decreases in the general price level known as deflation.

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